Plot Thickens in South Carolina Builders Liability Brouhaha

Plot Thickens in South Carolina Builders Liability Brouhaha

Plot Thickens in South Carolina Builders Liability
Brouhaha

Builders reacted with dismay in January when South
Carolina’s Supreme Court voted to limit insurance
policy coverage of damages caused by faulty subcontractor work
in the case
Crossmann Communities v. Harleysville Mutual (see
“
General Liability Doesn’t Cover Bad Workmanship, South
Carolina Court Rules,” Coastal Connection
1/25/11). But the state Homebuilders Association quickly
mobilized to counteract the court decision, convincing the
state legislature to pass a new law in May that reversed the
decision’s effect. The game’s not over yet,
however: days after Governor Nikki Haley
signed the bill into law on May 17, Harleysville went to
court on May 23 to block the new measure on constitutional
grounds.
To complicate the story even further, the state Supreme
Court agreed to re-hear the original case, allowing new oral
arguments on May 23 from a wide array of parties who had
submitted friend-of-the-court briefs about the dispute. In that
second hearing, the court took no notice of the
legislature’s move, according to an Insurance Coverage
Corner report
(“
What Happened at the Crossmann Communities
Rehearing?” by Michael Ethridge): “Very
early in the rehearing, Chief Justice Toal announced that the
Court would not permit any arguments based on the Legislation,
with the implication being that the Court would not take the
Legislation into consideration in reaching a
decision.”
The court’s revised ruling is expected this summer.
In light of the legislature’s move to explicitly
re-define the scope of insurance policy coverage, observers
discount any new court ruling’s importance. But with
Harleysville’s challenge to the new law still pending,
South Carolina builders remain uncertain about what protection
their liability policies can be counted on to provide
— and even some ongoing lawsuits, begun before the
court’s January decision was published, remain in
legal limbo.
Here’s a recap of events so far. In January, the
South Carolina Supreme Court ruled that insurance company
Harleysville was in the right when the company refused to help
pay damages, or to even defend builder Crossmann Communities
against homeowner lawsuits alleging faulty workmanship leading
to water intrusion and consequential damage to building
interiors and contents. The court’s reasoning hinged
on its definition of the word “occurrence,” a
common term in standard commercial general liability (CGL)
policies.
Courts in different states have taken different views about
whether faulty subcontractor work constitutes an
“occurrence” that would trigger coverage, or
is instead a foreseeable event that is the builder’s
own responsibility, noted the court. In South Carolina, the
court ruled, damage that takes place to the building as a
consequence of bad subcontractor work is not an
“occurrence,” and so is not covered. (Damage
suffered by a third party who’s not involved in the
construction contract — say, a passerby who is injured
as a result — is another matter, the court commented,
and might still be covered.)
Builders were shocked — because, they said, the new
rule was contrary to long-established common practice. From the
story “Leaky Legislation,” by Stacy Tellof in
the South Carolina Builder Journal (an HBA publication):
“Howard Cox of Palmetto Insurance explained that in 30
years of experience, no insurance company represented by his
company has ever denied a claim on the basis of the logic of
the Crossmann decision. Cox stated, ‘Bad work has
never been covered or paid for under General Liability
insurance, but the resulting damage
has.’”
But even among builders, there’s widespread
confusion about what is, and what is not, covered under CGL
policies. South Carolina HBA executive Mark Nix told Coastal
Connection, “When the decision first came out, I was
at the International Builders’ Show. I got calls just
when I landed in Florida from a couple of attorneys who told me
about it. And I was sitting at dinner with some builders that
night, and I asked them what they thought their insurance
covered; and I had 12 builders and I got 12 different
answers.” And it’s not just the builders,
says Nix: “even insurance brokers aren’t
sure.”
John Sadler is a licensed attorney whose independent
insurance company, Sadler & Company, based in Columbia,
S.C., specializes in insuring residential trade contractors,
home builders, remodelers, and light commercial general
contractors in the state. Sadler was sharply critical of the
Supreme Court ruling in a January 31 blog post
(“Crossmann v. Harleysville: Bad Decision For Builders
In SC,” by John Sadler). “The ruling in this
case is an insult to the many professional builders that
I’ve advised and insured over the past 25
years,” Sadler writes. “For those builder
clients that have had construction defect claims filed against
them, to say that they intended and expected the construction
problem to arise is not true in the majority of cases. Many of
the claims were frivolous lawsuits where the true cause of the
problem was lack of routine maintenance on the part of the
homeowner such as lack of caulking. Other claims resulted from
the use of synthetic stucco (EIFS) and similar products where
the builder had no reason to believe that such products would
ultimately be found to be inherently defective. However, the
majority of the claims were caused by unknowing mistakes in the
construction process where the builder certainly
didn’t expect a problem to arise.”
More to the point, argues Sadler, when first drafted by
insurance industry association in the 1940’s, the
standard CGL insurance policy was intended from the beginning
to define coverage broadly in its simplest form.
That’s why the industry has created an expanding set
of “policy endorsements” that narrow the
scope of the policy by excluding particular events or
situations — a menu that buyers and sellers of
insurance can choose from to craft an appropriate policy at a
fair price.
Writes Sadler: “In a free market, insurance
carriers should be able to decide whether or not to write
General Liability policies for builders as well as their
approach to coverage for construction defect claims. Some may
want to exclude all property damage arising from construction
defect and others may want to provide total or partial
coverage. The design of the General Liability policy allows
this flexibility through the use of special policy endorsements
to alter or clarify the coverages of the basic policy form.
Carriers that wish to insure contractors, but avoid paying
construction defect claims, merely need to add the ISO policy
endorsement entitled “Exclusion – Damage To
Your Work Performed By Subcontractors On Your Behalf”
(CG2294). This endorsement has been in widespread use since
2004 and has proven to be very effective in denying
construction defect claims.... At the present time, several
carriers in South Carolina are using special property damage
endorsements that they drafted to provide partial coverage to
builders for construction defect claims. Most of these
endorsements take the form of excluding coverage for property
damage to the faulty work itself, but providing coverage for
resulting property damage to non-faulty work. Many within the
building community think that this is an acceptable
compromise.”
Says the HBA’s Mark Nix, “If you want to
have some of these provisions in the contract that take out
some of the coverage, that’s fine, as long as the
builder knows what he’s paying for. But the way things
have been, you can ask different insurance agents, and even
they would tell you — if I had six different insurance
agents, I’d get six different answers about
what’s covered.”
And problems arise when insurance companies want to avoid
paying for damages in connection with policies written before
the CG2294 endorsement, narrowing the defined coverage, became
widely used. That’s when insurance providers may fall
back on hair-splitting about what is, or is not, an
“occurrence.” South Carolina’s new
law is intended to cut off that option for the insurance
industry. But there’s a hitch: insurance company
Harleysville, which has sued to block the law, may have a
viable case grounded in both the U.S. and the South Carolina
constitutions.
The legal blog “Insurance Coverage Corner”
has a thumbnail sketch of Harleysville’s complaint
(“
Constitutional Challenge to the South Carolina Legislation
Defining Occurrence,” by Katherine W. Sullivan).
On the one hand, Harleysville argues, “To the extent
the statute is applied retroactively, it violates the
separation of powers doctrine set forth in Article I, &sect;
8 of the South Carolina Constitution: Article I, &sect; 8
‘prohibits the legislature from overruling a decision
by the Supreme Court.’” And, contends
Harleysville, the new law also violates the Contracts Clause of
the U.S. Constitution, which provides that "No law impairing
the obligation of contracts shall be passed.” The
statute, Harleysville argues, “purports to
retroactively alter and impair CGL insurance contracts already
in existence prior to the enactment of the bill."
If Harleysville succeeds in attacking the retroactive nature
of the law, that won’t stop the law from more clearly
and precisely defining coverage for future insurance contracts.
That’s a beneficial effect, argues Frank Norris of
insurance agency Frank B. Norris and Co. Norris told the South
Carolina Builder Journal, “Something is wrong when
insurance companies cannot issue a liability policy that the
builder can understand, much less the insurance agent.
Something is wrong when multiple state supreme courts spend
thousands of hours of legal time trying to interpret the CGL
policy issued by the Insurance Service Office in
1986.” Said Norris: “We represent one
insurance company that has an endorsement that we like that
clarifies coverage. Faulty work is not covered, but the
resulting damage is covered. We wish other companies would take
this same position and not hide behind the Crossmann decision
when adjusting claims.”
But Mark Nix says that for builders, it’s important
for the new law to have a retroactive effect — at
least enough to bring some order to the process for cases that
were already in the works when the Supreme Court’s
January opinion was released. Nix says, “We had
several cases that we knew of, already in litigation or going
into some other part of the process, where insurance companies
just stopped — they said, ‘We’re not
meeting anymore, because of this case. We’re leaving
it high and dry.’ Even though they had been paying, or
representing the builder through attorneys — they just
walked away.”
For Nix and the builders he represents, the
legislature’s action doesn’t interfere with
an existing contract — on the contrary, he argues, the
law simply reaffirms the previously existing understanding of
the contracts entered into in good faith by both sides. Says
Nix: “That’s the biggest point we put to the
legislators. You know, we paid for a product, we were told
‘This is what it covers’ — and if
you look at a historical view of it, it shows that
it’s covered in the past. Well, why would it change at
this point?”
In the end, the Supreme Court’s decision after the
re-hearing may narrow the scope of Harleysville’s
victory anyway — taking the company off the hook for
damages in Crossmann’s case, but without the sweeping
implications for other builders and other insurance companies
in other construction projects. Some observers argue that the
court should have restricted its ruling to a narrower scenario
in which the work was so plainly defective that its damaging
consequences would in fact have amounted to an ordinary
contract violation, rather than an unforeseen incident
— deciding the case, in effect, on the facts rather
than on the law. That way, builders could still retain clear
coverage for the sort of typical product failures or
“unknowing mistakes” John Sadler
describes.
Supreme Court Justice Costa M. Pleicones, in a short
concurring opinion, made a gesture toward such a finer
distinction between unforeseen bad outcomes, and the
foreseeable results of bad work — and he said that
Crossmann’s work in the buildings at issue had plainly
crossed that line. Wrote Pleicones, “the homeowners
allege ‘negligent construction on many fronts,
including improper installation of siding, windows, flashing at
the windows, walkway floor sheathing, and wind resistant tie
down straps; deterioration of structural columns and structural
components; failure to completely install the building wrap;
flooding of units; water infiltration; failure to properly
attach handrails; failure to properly construct emergency
stairs; termite infestation and destruction; and defective
storm water drainage system.’ This complaint alleges
nothing more than negligent acts constituting faulty
workmanship, not an
‘occurrence.’”
Argues Frank Norris, “Our state supreme court
should have warned insurance companies that Crossmann was an
unusual case. The work was so shoddy that resulting damage was
to be expected. But it should not have applied across the board
for other cases.”